Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

THE DAILY EDGE: 7 JUNE 2019

Payroll employment edges up by 75,000 in May; unemployment rate remains at 3.6%
  • Total nonfarm payroll employment edged up in May (+75,000). Monthly job gains have averaged 164,000 in 2019, compared with an average gain of 223,000 per month in 2018.
  • The change in total nonfarm payroll employment for March was revised down from +189,000 to +153,000, and the change for April was revised down from +263,000 to +224,000. With these revisions, employment gains in March and April combined were 75,000 less than previously reported.
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  • In May, average hourly earnings for all employees on private nonfarm payrolls increased by 6 cents to $27.83. Over the year, average hourly earnings have increased by 3.1 percent. Average hourly earnings of private-sector production and nonsupervisory employees increased by 7 cents to $23.38 in May. [+3.4%]
  • The average workweek for all employees on private nonfarm payrolls was unchanged at 34.4 hours in May. In manufacturing, the average workweek and overtime hours were unchanged at 40.6 hours and 3.4 hours, respectively.
As Mexico-U.S. talks progress, markets rise on hopes a deal could be close  Mexican and U.S. officials held a second day of talks on trade and migration on Thursday, with markets rebounding on optimism a deal could be close, although it was unclear if Mexican pledges to curb migration flows were enough to persuade the Trump administration to postpone tariffs.

(…) U.S. Vice President Mike Pence said Mexico had offered “more” on Thursday than on Wednesday but that it would be up to Trump – who returns from a European trip on Friday – to decide if it were enough. (…)

Trump did not specify if he meant the DJII or the S&P 500 Index. Winking smile

Rise in U.S. Worker Productivity Could Be Difficult to Maintain U.S. workers’ efficiency improved at the best rate in nearly a decade, revised data confirmed, but that pace could prove difficult to maintain with economic growth expected to cool as the year progresses.

The productivity of nonfarm workers increased 2.4% from a year earlier in the first quarter, the Labor Department said Thursday. That was the best year-over-year gain since the third quarter of 2010, when the economy was just emerging from a deep recession.

Compared with the previous quarter, productivity increased at a 3.4% seasonally adjusted annual rate in the first quarter. That was a slight downward revision from last month’s initial estimate of a 3.6% gain. (…)

While the latest data show that worker efficiency has improved, the pace of gains is near average by historical standards. Since the end of World War II through 2018—including both expansions and recessions—productivity rose at an average annual rate of 2.1%. In the previous economic cycle, from 2000 to 2007, productivity rose at a 2.7% annual rate.

Thursday’s report showed compensation expenses, as measured by unit-labor costs, decreased at a 1.6% annual rate in the January-through-March period from the fourth quarter of 2018. That compared with an earlier estimate of 0.9% lower. (…)

This stat can be significantly revised so should be taken with reserves. As you can see, unit labor costs almost never decline YoY except immediately after recessions.

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China has ‘tremendous’ room to adjust monetary policy if trade war deepens, PBOC head says: report

“We have plenty of room in interest rates, we have plenty of room in required reserve ratio rate, and also for the fiscal, monetary policy tool kit, I think the room for adjustment is tremendous,” Yi said, according to the news outlet. He said he expected a “productive talk, as always,” when he meets with Treasury Secretary Steven Mnuchin on the sidelines of the G-20 finance ministers meeting, but that the risk of a trade war remains “uncertain and difficult.”

Germany: Horrible start to the second quarter Disappointing April data from industrial production and trade suggest that the latest ECB’s dovishness is justified

Industrial production fell by a sharp 1.9% month-on-month in April, from 0.5% MoM in March, the first drop since January this year. On the year, industrial production was down by 1.8%. Production in all sectors dropped, except for activity in the construction sector.

At the same time, German exports (seasonally and calendar adjusted) fell like a stone, dropping by 3.7% MoM in April, from 1.6% MoM in March. Imports decreased by 1.3% MoM, from 0.4% MoM in March. As a result, the trade balance shrank to €17.94 billion in April from €22.6 billion in March.

Let’s be clear, this is a horrible start to the second quarter for German industry, as global trade tensions as well as temporary problems in the automotive sector and chemical industry have left their marks. One-off factors should have disappeared by now and even turned into temporary positives. (…) (ING) (Charts from Bloomberg and Markit)

German industrial output plunged the most in almost four years

MARKIT EUROPE AUTO AND PARTS PMIimage
Selling prices fall at copper users amid weak demand and low cost inflation

At 49.4 in May, the seasonally adjusted Global Copper Users Purchasing Managers Index™ (PMI) – a composite indicator designed to give an accurate overview of operating conditions at manufacturers identified as heavy users of copper – ticked up from 49.1 in April, to signal a similarly marginal deterioration in business conditions. The reading extended the current sequence of decline to six months, but indicated the weakest drop in this period. (…)

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Demand weakness still gripped the global copper using industry in May, as the latest PMI data signalled another decline in new orders, albeit to the least extent for six months. This run of poor performance has finally prompted manufacturers to reduce their selling prices for the first time since August 2016, revealing the level of angst among businesses that markets may not recover in the short run. (…)

Euro-Area Consumers Gave Economy a Lift at the Start of 2019

Household expenditure jumped 0.5% in the first quarter, the most in a year, helping overall economic expansion accelerate to 0.4%. Investment and net trade also added to growth in the period, while there was a big drag — 0.3 percentage points — from inventories. (…)

Consumer spending and investment were big drivers of growth at start of 2019
Huawei Signs Contract To Build 5G Network In Russia

Huawei cuts or cancels orders to major suppliers after U.S. blacklisting: report

Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC) confirmed that orders from Huawei have declined after U.S. President Donald Trump imposed a ban on the Chinese company on national security grounds, according to the report.

Huawei has also downgraded its forecast for total smartphone shipments in the second half of 2019 by “about 20 per cent to 30 per cent” from the previous estimate, the Nikkei reported. (…)

Optical components maker Lumentum Holdings Inc. ceased all its shipments to Huawei, while U.S. chip maker Qorvo Inc. said it expects first-quarter revenue to take a US$50-million hit due to a halt in shipments to the Chinese company.

Huawei is allowed to buy U.S. goods until Aug. 19 to maintain existing telecoms networks and provide software updates to its smartphones.

SENTIMENT WATCH
Investors, Buy the Dips: Recession Worry Is Overblown for Now

It may be time for investors to stop worrying and learn to love the economic boom. The inevitable bust could be further off than is commonly believed, but it could also be more painful. (…)

But if the business cycle truly is getting stretched, the expansion could last a few more years. This suggests investors should continue to buy stock-market dips—a successful strategy for the past 10 years. (…)

Investors should stop obsessing about an imminent recession but start planning for a financial storm some time in the mid-2020s.

I rest my case. Confused smile

That thing settled, some naysayers still remain:

  • PMI surveys signal weakest global economic growth for three years
  • Global PMI™ falls to lowest since June 2016, while future expectations hit a survey low
  • Stalling manufacturing sector joined by weaker services growth
  • Jobs and investment indicators fall amid rising risk aversion; price pressure also ease
  • Developed world growth down to lowest since 2012 as US joins the slow lane
  • Brazil downturn leads emerging markets lower

While the PMI had hinted at a modest pick-up in the pace of global economic growth in February and March, the data for the second quarter are looking decidedly gloomy, pointing to the weakest rate of expansion since the third quarter of 2016. The survey data are indicative of worldwide GDP rising at an annual pace of 2.0% (at market prices) so far in the second quarter, down from 2.4% in the first quarter, though momentum was lost to around 1.75% in May alone. (…)

A further loss of momentum is signalled for coming months via weaker new order inflows, falling backlogs of work and a drop in business expectations. Inflows of new work showed the smallest rise for three years, falling in manufacturing and growing at their slowest pace since mid-2016 in services. (…)

A major change in May was a weakened rate of expansion in the US, which joined the other major developed economies of the eurozone, UK and Japan in the slow lane to push developed world growth to its lowest since 2012. Emerging market growth also eased, reflecting a renewed downturn in Brazil and softer expansions in China and Russia. (…)

  • David Rosenberg remains obsessed:

With a recession inevitable, now is the time for every investor to hold on to their hat

(…) Perhaps the most important data point this week, with due deference to the jobs report, was the number of times the Fed Beige Book used the word “uncertain” to describe the outlook – the most in six years. And in uncertain times, the private sector tends to boost its savings rates at the expense of spending growth, and those savings in turn gravitate to safe havens – one reason why bonds and gold have reasserted their traditional roles in uncertain times. (…)

THE DAILY EDGE: 6 JUNE 2019

Rate Cuts Aren’t as Certain as Markets Think Interest rate expectations have changed dramatically, despite few concrete signs of change in the economic outlook

(…) Moreover, the key reason the global economy is weakening isn’t tariffs, but the structural slowdown in the Chinese economy, which is hurting manufacturing orders around the world. There is little evidence that this structural issue has worsened in recent weeks, nor that Chinese policy makers have given up on ramping up fiscal and credit stimulus to offset them.

Of course, investors’ knee-jerk reaction on rates could still be justified if the Fed panics at the sight of trade negotiations breaking down. Or if China’s structural woes are worse than anticipated. Or if U.S. households, who have been tapping more into their savings, suddenly slash consumption.

However, there is no indication that any of this is true, particularly when it comes to the domestic economy, which is looking robust in the U.S. and even in Europe. Economists’ forecasts of U.S. growth haven’t been downgraded much, according to an average compiled by data provider FactSet. (…)

Robust? “In the U.S. and even in Europe”? Look again.

First chart is the USA:

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Goldman Sachs’ U.S. Current Activity Indicator:

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Globally synchronized slowdown. This is from Topdown Charts:

@Callum_Thomas

This Global Service chart is from J.P. Morgan:

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True, we have seen similar weakness before. But central banks are done we their QEs and the U.S. tax reform is behind us and China is not stimulating like before and the tariffs and Brexit …

But no worry. We’ll be saved by the Service economy:

U.S. Service-Sector Economy Powers on Despite Global Headwinds Service-sector activity across the U.S. grew at a faster rate in May, signaling a key segment of the economy remains on solid ground despite slowing global growth and trade tensions.

The Institute for Supply Management on Wednesday said its nonmanufacturing index—tracking industries including health care, finance and restaurants—rose to 56.9 in May from 55.5 in April. (…)

The IHS Markit U.S. services business activity index logged in at 50.9 last month, down from 53 in April. This signaled an expansion in services but was the lowest reading since February 2016.

The two reports, based on separate surveys of businesses, fit with other signs that the overall economy was expanding at a good pace this spring, though more slowly than last year and despite some weak spots. Services accounts for about 88% of U.S. gross domestic product, according to ISM. (…)

“We’re not heading for an immediate downturn,” said Jonathan Millar, Barclays senior U.S. economist. “You have a services sector that is offsetting some of the weakness that’s coming from manufacturing.”

Employment activity in service industries was stronger in May than April, according to the ISM report, indicating the labor market is running strong but not too hot. New orders and business activity were also up last month. (…)

Yes says the ISM:

Hmmm…says Markit which saw its own U.S. Services PMI plunge in recent months. As shown on June 4, Markit’s Manufacturing PMI has proven more reliable than the ISM’s. I put more weight on Markit’s Services PMI.

(…) new orders received by service providers increased at only a marginal rate in May. The rise was the softest since March 2016 as firms commonly stated that less robust demand conditions weighed on new business growth. Meanwhile, new export orders were broadly unchanged during May, with the respective seasonally adjusted index posting fractionally above the 50.0 no change mark.

Subsequently, service sector firms registered a lower degree of optimism towards output over the coming 12 months. Business confidence was at its lowest level since June 2016 as service providers highlighted concerns surrounding softer demand conditions and uncertainty around ongoing global trade tensions. The level of positive sentiment was well below the series trend and muted overall.

Less robust client demand put pressure on firms to remain competitive as companies left output charges broadly unchanged in May. The respective seasonally adjusted index dipped below to crucial 50.0 neutral mark for the first time since February 2016, as some companies sought to retain clients through price discounting.

Fed’s Beige Book Sees Modest Growth

Economic activity picked up slightly this spring as firms largely shrugged off the effect of tariffs, according to a Federal Reserve report released Wednesday.

The Fed’s 12 regional districts reported modest growth in April and May, “a slight improvement over the previous period,” the central bank said in its “beige book” report collecting anecdotes from business contacts from around the country. The report was based on information collected through May 24, before President Trump announced plans for new tariffs on Mexico.

The report suggests the renewal of trade tensions with China has yet to have much of a significant impact on American manufacturers, although many expressed worries about the future. (…)

Meanwhile, contacts around the country said the labor market remained exceedingly tight, putting upward pressure on wages, particularly in the retail and tourism industries. (…) Retailers remained upbeat, with several citing growth in the online retail market. (…)

One note of concern in the report came from the agricultural sector, where heavy rains could result in lower corn and soy harvests in the Midwest.

Wet weather delayed crop plantings across the region and some farmers in the Minneapolis area worried they wouldn’t be able to get a crop in at all this year. Farm contacts in Nebraska and Missouri reported lower incomes and slower repayment rates on loans.

But the wet spring was a boon in Texas, where it helped the wheat crop and made for greener pastures for cattle. (…)

More from the Beige Book:

  • stronger employment growth continued to be constrained by tight labor markets, with Districts citing shortages of both
    high- and low-skill workers    . Competition for workers reportedly applied some wage pressures across a wide range of
    occupations and induced improvements in benefits to attract more workers and to improve retention of existing employees,
    according to several Districts. However, overall wage pressures remained relatively subdued given low unemployment
    rates; a majority of Districts reported modest or moderate wage growth.
  • Overall prices continued to increase at a modest pace in most Districts since the previous report. While several Districts
    noted faster growth in input prices than in final selling prices. (…) Retailers generally reported flat to slightly increased selling prices.
  • The overall sentiment of the Beige Book language continues to soften. (The Daily Shot)

Source: @JeoffHall

Nothing “robust” in there!

But should we care much about Services?

As you can see below, the S&P 500 Index has closely tracked the global manufacturing PMI. When manufacturers expanded at a faster rate, stocks jumped higher year-over-year. And when they slowed or even shrank, stocks sold off. (U.S. Global Investors)

India cuts interest rate to lowest level in 9 years Central bank lowers forecast for GDP growth and signals possible further easing
EARNINGS WATCH

We now have 494 reports in for Q1 results. The beat rate is 76% and the surprise factor +6.1% (median +5.6%). The blended growth rate is +1.6% (+3.0% ex-Energy) but 5 sectors are in the red.

Q2 estimates keep coming down: now only +0.5% (same ex-E). Importantly, revenue growth is slowing big time from +5.6% in Q1 to +3.8% in Q2.

Trailing EPS are now $163.91. The Rule of 20 P/E is back to 19.4, slightly undervalued.

The Rule of 20 Fair Value ($163.91 x (20 – 2.1) is 2934, 3.3% above today’s pre-opening. The worry is that the FV is stalling along with EPS and inflation (yellow line).

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A stalled or declining FV puts equity markets more susceptible to sentiment swings as the underlying fundamental support is not rising.

If GS is right (read below), inflation will act as a headwind in coming months.

(…) Economists at Goldman Sachs estimate U.S. tariffs imposed or proposed on steel, aluminum, solar panels, washing machines and imports from China now equal an annualized $200 billion. Adding all threatened tariffs on Mexico brings that to $288 billion by the end of October. At 1.4% of GDP, that is roughly equivalent to the Arab embargo “oil tax.” That doesn’t include the hit from China’s—and potentially Mexico’s—retaliatory tariffs, as well as severed supplier relationships because of U.S. sanctions on Huawei Technologies Co.(…)

So while Goldman estimates the tariffs could add up to 1.25 percentage points to inflation, the Fed is likely to worry more about their impact on growth and cut rates rather than raise them.

The benefit of higher prices on imported oil went to foreign oil producers. By contrast, tariffs are paid to the U.S. Treasury, which could spend the money to offset some harm from the levies. (…)

Rather than manufacture in the U.S., many importers are contemplating shifting Chinese production to Vietnam, raising prices or dropping products most affected by tariffs. Some had planned to shift production to Mexico but they may have to reconsider. As with the oil shock, these adjustments could take years and add countless inefficiencies, chipping away at productivity. (…)

And there remains an earnings risk:

Stocks are at their cheapest valuations in months. Shares of companies in the S&P 500 are currently trading at 15.7 times their earnings over the next 12 months, down from nearly 17 times in early May, according to FactSet. (…)

(…) The tariffs on Chinese imports are expected to lower the S&P 500’s earnings per share by 1.2% for all of 2019, Bank of America Merrill Lynch said in a research note this week. Goldman Sachs cut its 2019 earnings forecast by 2% due to additional tariffs. But analysts’ consensus earnings estimates for the year have fallen just 0.1% since Mr. Trump threatened new tariffs last month, Bank of America added, suggesting much of the market hasn’t fully grasped the potential effects of the White House’s trade actions.

And the tariffs Mr. Trump said he plans to implement on imports from Mexico only muddies the outlook further. S&P 500 earnings-per-share could fall another 0.6% this year, if tariffs on Mexican imports reach 25% in the fall, assuming companies boost prices to offset the impact, according to Bank of America. Goldman Sachs, meanwhile, projects a 5% hit to the 2019 earnings of companies in the broad index. (…)

I showed this chart 2 weeks ago:

FYI, the last 6 months EPS average is $162.47. Less 10% = $146.22 which would take FV to $2617 is inflation is 2.1%.

Certainly not a time to bet the farm on equities, is it?

Auto “It has become clear that the political conditions in France do not currently exist for such a combination to proceed successfully,” Fiat Chrysler said.

  • “we see a 40% probability that the US will impose tariffs on EU autos this year.” (Goldman Sachs)